When Gray is Good : International Price Discrimination, Gray Markets, and Their Impact on Consumers

We study a firm's product design, distribution, and pricing problem when it is presented with the opportunity to enter a foreign market. Specifically, we focus on identifying the product quality, product access, and consumer welfare outcomes when the firm decides to pursue new consumers in a foreign market. By analyzing a parsimonius model with heterogeneous consumer types in the firm's home market, we find that entering a foreign market expands access and improves welfare for low-valuation consumers in the home market in the presence of a gray market. This results from the firm's effort to dissuade gray market activity by leaving additional surplus to local consumers. The firm achieves this through the downward manipulation of price and quality in response to the threat from the gray market. We also explore other strategies that the firm can use to dissuade gray market activity such as product versioning and negative advertising against gray market products. We find that these strategies can aid the firm's ambitions for foreign expansion by relieving the pressure of cannibalization from the gray market, but also that they do not hurt low-valuation consumers in the home market by restricting product access